22 June 2011

Middle Class Income Tax Rates At Roughly 40 Year Lows

Average and marginal income taxes for those making the median income and twice the median income are mostly at forty year lows. Taxpayers making half the median income have never paid less in income taxes (the average income tax rate is a negative percentage of income), but have the highest marginal income tax rates of all taxpayers, due to the effects of various refundable tax credits, the standard deduction and personal exemptions.

The bottom line, here, and across the board in the area of federal taxation, is that in a time period where we have federal budget deficits, it has never made less sense to close those deficits entirely or mostly through spending cuts. We have large budget deficits, at the federal level, and have almost overconstrained state budgets in Colorado that have forced painful cuts, mostly because we made deep tax cuts during an economic boom while fighting two regional wars, without paying for them.

From the perspective of overall economic growth and the employment situation, we should be spending more in the public sector, at a time when private sector demand is anemic and investment activity is tepid. Instead, we are cutting back on public services at a time when our economy has massive amounts of slack resources and above average demand for public services.

Also, our current extremely generous tax code is full of special interest tax breaks that constitutes autopilot meddling with private economic decisions that picks winners and losers in the business world, rather than letting the marketplace carry out that function, continues to be a force driving increasing systemic risk in our economy, and dramatically increases the dead weight transaction costs associated with tax code compliance and tax planning that its one of the regulatory costs of government that truly does hit small businesses the hardest.

Accumulated tax code crud is inevitable. A tax code will never be ideal once and for all. Revenue needs change, new kinds of transactions are invented, politicians are compelled to respond to urgent cries from the public for tax tweaks great and small to be responsive. But, like a garden, the tax code requires continuous weeding of provisions that damage the whole and planting of improved provisions if it is to satisfy the public need for revenue in a way that doesn't do unnecessary harm to the economy. Congress has put off that unpleasant task for too long, and the result has been ugly.

But, the solution is not to shut down the IRS, to hire private collectors, to pass further special interest tax break, to pass a consumption tax, or to mimic sometimes lower foreign corporate tax rates without expanding the tax base as countries with lower corporate tax rate do. Instead, it is to take on the unpleasant business of repealing a great many tax breaks, in a way that increases the amount of revenue produced by the income tax, makes the tax code more economically neutral, and reduces the complexity and tax planning opportunities that great dead weight drags on the economy.